Raytheon 2005 Annual Report Download - page 58

Operating cash flow from continuing operations was $2.5 billion in 2005, $2.1 billion in 2004, and $2.6 billion in 2003.
Total debt was $4.5 billion at December 31, 2005 versus $5.2 billion at December 31, 2004.
CRITICAL ACCOUNTING POLICIES
The Company’s consolidated financial statements are based on the application of generally accepted accounting
principles which requires the Company to make estimates and assumptions about future events that affect the amounts
reported in its financial statements and the accompanying notes. Future events and their effects cannot be determined
with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ
from those estimates, and any such differences may be material to the Company’s financial statements. The Company
believes that the policies set forth below may involve a higher degree of judgment and complexity in their application
than the Company’s other accounting policies and represent the critical accounting policies used in the preparation of its
financial statements. The Company believes its judgments related to these accounting policies are appropriate. However,
if different assumptions or conditions were to prevail, the results could be materially different from the amounts
recorded.
Revenue Recognition—Sales under long-term contracts generally are recorded under the percentage of completion
method. Incurred costs and estimated gross margins are recorded as sales when work is performed based on the
percentage that incurred costs bear to the Company’s estimates of total costs and contract value. Cost estimates include
direct and indirect costs such as labor, materials, warranty, and overhead. Some contracts contain incentive provisions
based upon performance in relation to established targets, which are included at estimated realizable value. Contract
change orders and claims are included when they can be reliably estimated and realization is considered probable. Due to
the long-term nature of many of the Company’s programs, developing estimates of total costs and contract value often
requires significant judgment. Factors that must be considered in estimating the work to be completed and ultimate
contract recovery include labor productivity and availability, the nature and complexity of the work to be performed, the
impact of change orders, availability of materials, the impact of delayed performance, availability and timing of funding
from the customer, award fee estimations, and the recoverability of claims. In 2005, 2004, and 2003, operating income as
a percent of net sales for the government and defense businesses did not vary by more than 2.3%. A 2.3% change in
operating income as a percent of net sales for the government and defense businesses in 2005 would change the
Company’s operating income by approximately $460 million.
Lot Accounting—The Company uses lot accounting for new commercial aircraft introductions at Raytheon Aircraft.
Lot accounting involves selecting an initial lot size at the time a new aircraft begins to be delivered and measuring an
average margin over the entire lot for each aircraft sold. The costs attributed to aircraft delivered are based on the
estimated average margin of all aircraft in the lot and are determined under the learning curve concept, which anticipates
a predictable decrease in unit costs from cost reduction initiatives and as tasks and production techniques become more
efficient through repetition. Once the initial lot has been completed, the use of lot accounting is discontinued. The
selection of lot size is a critical judgment. The Company determines lot size based on several factors, including the size of
firm backlog, market and competitive conditions, the expected annual production for the aircraft, and experience on
similar new aircraft. The size of the initial lot for the Beechcraft Premier I is 200 units. The size of the initial lot for the
Hawker 4000 is 75 units. A 5% increase in the remaining estimated costs to produce the initial lots of these two aircraft
would reduce the Company’s operating income by approximately $64 million in the aggregate.
Valuation of Used Aircraft and Aircraft Materials and Parts—The valuation of used aircraft in inventories,
which are stated at cost, but not in excess of realizable value, requires significant judgment. The valuation of used aircraft
is also considered in assessing the realizable value of certain commuter aircraft-related assets which serve as collateral for
the underlying financing arrangements. As part of the assessment of realizable value, the Company evaluates many factors
including current market conditions, future market conditions, the age and condition of the aircraft, and availability
levels for the aircraft in the market. A 5% decrease in the aggregate realizable value of used aircraft in inventory at
December 31, 2005, would result in an impairment charge of approximately $10 million. The valuation of aircraft
materials and parts that support the worldwide fleet of aircraft, which are stated at cost, but not in excess of realizable
value, also requires significant judgment. As part of the assessment of realizable value, the Company evaluates many
factors including the expected useful life of the aircraft, some of which have remained in service for up to 50 years. A 5%
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